Chapter 5 - Earnings Tips

It’s also important to look at a firm’s earnings in relation to other aspects of its business.

A huge increase in earnings could be the result of a recent merger or acquisition rather than good old-fashioned organic growth. A merger or acquisition is not necessarily a bad thing  often, it’s the catalyst for plenty of future growth  but it helps to understand why profit is growing. And that gives you a better picture of the company’s overall health.

Take a look at the firm’s sales growth, as well as its earnings growth. If sales are sluggish while earnings surge ahead, that might indicate cost-cutting moves that boost earnings now, but will disappear when the company runs out of things to slash.

And don’t be impressed by a company’s claims of “record earnings.” The firm’s earnings could rise just 1% and it could still make that claim. You want to see standout growth in earnings. So look for quarterly and yearly increases of at least 25% -- or higher is even better.

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